An Energy Prospect With Texas-Sized Upside

By David Englander

WHEN THE PRICE OF NATURAL GAS hit an all-time high last summer, shares of (ticker: EP), a pipeline operator and exploration-and-production company, were right up there with it, topping out above $21. And when natural gas fell, El Paso’s shares fell just as hard. The stock bottomed below $5.50 in November, and again in March, before rebounding to $8.15 at yesterday’s close. They could advance to $12 in a year, for a gain of nearly 50%.

El Paso relies heavily on debt to fund its business, so when it looked like the debt markets would stay closed forever, investors headed for the doors. At the time, the company had $14.5 billion in debt, $1.05 billion of which comes due this year. Plus, El Paso already has sunk $1 billion into a new pipeline project that will require another $2 billion to complete.

Disaster, however, did not ensue. The capital markets improved, the company prefunded its debt, and last week announced it was close to finding a joint-venture partner to complete the new pipeline project.

As 93% of El Paso’s pipeline capacity is under 10-year contracts, the company will have no trouble meeting its interest payments, despite continued weak prices for gas. The new pipeline which is expected to be completed in 2011, will add further capacity. The company has an $8 billion backlog.

The E&P side of the business, meanwhile, has little downside; 70% of production has been hedged through 2010. This year, the average floor price is $9 per thousand cubic feet (Mcf) of gas—more than double the current price. Down the road, the prospect for natural gas looks good. Production cuts this past year eventually will translate into lower supply. Demand, which has been depressed due to economic weakness, will rebound, and gas prices will rise as producers scramble to bring on new capacity.

Last year El Paso earned $923 million, or $1.28 a share, on revenue of $5.4 billion. This year EPS could slip to 93 cents a share. At their current level, El Paso’s shares trade at just 9 times trough earnings.

Earnings will be helped if capital markets continue to improve, enabling the company to fund its projects with cheaper capital. Add an improvement in natural-gas prices, and the shares could lift off anew.

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TWICE IN THE PAST SIX MONTHS the stock market has given investors a chance to buy shares of (MR), China’s largest maker of patient monitoring systems, at a deep discount. Now it’s time to cash in.

In November 2008, a survey released by the American Hospital Association noted that 45% of U.S. hospitals planned to delay equipment purchases in ’09. The stock fell 24% in a day, even though only 9% of the company’s profit is expected to come from the U.S. this year. We called the selloff a “clear overreaction,” noting that the “vast majority of Mindray’s business comes from low-ticket products that aren’t postponable, and recommended buying the shares at $14.80.

After recovering to $24-and-change in February, the shares took another pounding, as investors began to fret over the Obama administration’s rhetoric on health care. Again, we thought the reaction was again overdone. We reiterated our recommendation in March to buy the stock when it fell below $18.
After bouncing above our $25 target price Monday, the shares closed yesterday at $22.52. This time the worries could be real. On Tuesday the company missed first-quarter earnings expectations and management reduced its guidance for the year. The problems: weak export sales and uncertainty about the health-care spending by the Chinese government.

The combined gains from our two Alerts are 77.7%, compared with 40% for the DJ Total Stock Market index. Over the long term, the shares are likely to prosper. Over the short term they could pull back into the teens. Take your gains while you can.

Fleming Meeks is executive editor of Barron’s and the founding editor of Barron’s Daily Stock Alert. He previously served as editor of SmartMoney, The Wall Street Journal Magazine, and assistant managing editor of Barron’s. Meeks began his career in journalism 25 years ago as a staff writer for Forbes. He holds a B.A. degree from Windham College.If you have comments or questions, please contact him at fleming.meeks@barrons.com

David Englander is a staff writer for the Barron’s Daily Stock Alert. He joined in 2008 as a reporter. Prior to Barron’s, he worked as a consultant, advising Fortune 500 companies on growth strategies and mergers and acquisitions. He has also worked as an independent equity analyst. Englander holds a B.A. from Amherst College, an M.B.A. from the University of Rochester and an M.F.A. from Columbia University.If you have comments or questions, please contact him at david.englander@barrons.com

Alexander Eule has been a staff writer for Barron’s Daily Stock Alert since 2010 and a reporter for Barrons.com since 2006. Prior to the Stock Alert, Eule wrote the site’s Barron’s Take and Weekday Trader features, offering frequent insights into individual stocks and the broad market. He holds a B.A. from Columbia College and an M.S. in Journalism from Columbia University.If you have comments or questions, please contact him at alexander.eule@barrons.com